Module 9 10 ACCTG 31 1

KORBEL FOUNDATION COLLEGE, INC.
Purok Spring 1, Brgy. Morales, Koronadal City

Contact No. 228-1996/887-2051
Business Department
korbelbusinessdepartment@gmail.com
Lecturer: Charlou C. Calipayan A.Y. 2 ND SEMESTER, 2020-2021
SUBJECT CODE: ACCTG 31

MODULE NO: Module 9 – 10
SUBJECT NAME: COST ACCOUNTING AND CONTROL
TOPIC: Accounting for Factory Overhead
OBJECTIVE/S:
At the end of the lecture/discussion/week, the student should be able to:
 Define factory overhead
 Compute for factory overhead rate
 Allocate service cost
 Compute for cost base on activity (ABC)
 Computation of Factory overhead variance
PART 1. LECTURE/DISCUSSION
CHAPTER 7
ACCOUNTING FOR FACTORY OVERHEAD
ACCOUNTING FOR FACTORY OVERHEAD
ALL costs incurred in the factory that are not direct materials or direct labor are generally termed as
factory overhead.one method to determine whether a factory expenditure is a factory overhead item is to
company it to the classification standard established for direct materials and direct labor costs. If certification
cannot be charged to either of these two “direct” factory accounts, it is classified as factory overhead.
CLASSIFICATION OF OVERHEAD
1. Indirect materials
2. Indirect labor
3. Indirect expenses- all items of manufacturing overhead not classifiable as indirect materials or indirect labor.
BUDGETING FACTORY OVERHEAD COST
Budgeting are managements operating plans expressed in quantitative terms, such as units of production and
related cost. After factory overhead cost have been classified as either fixed, or variable, budgets can be prepared for
expected levels of production. The separation of fixed and variable cost components permits the company to prepare a
flexible budget.
FACTORY TO BE CONSIDERED IN THE COMPUTATION OF OVERHEAD RATE

1. BASE TO BE USED
 Physical output
 Direct materials cost
 Direct labor cost
 Direct labor hours
 Machine hours
2. ACTIVITY LEVEL TO USE
 Normal capacity
 expected actual capacity
3. INCLUSION OR EXCLUSING OF FIXED FACTORY OVERHEAD
 Absorption costing- method use for cost accounting
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 Direct costing- method use for internal reporting ( management service)

4. USE OF SINGLE RATE OR SEVERAL RATES
 Plant-wide or blanket rate- one rate for all producing departments
 Departmentalized rate- one rate for each producing department.
BASE TO BE USED
The base to be used should be related to functions represent by the overhead cost being applied. If factory
overhead is labor- oriented, the most appropriate base to use is direct labor hours and direct labor cost. If factory is
investment –oriented, related operation of machinery, then the most appropriate base will be machine hours. On the
other hand, if factory overhead is material-oriented, then material cost might be considered as the most appropriate
base. The simplest of all base is physical output or units of production.
ILLUSTRATIVE PROBLEM
The round table company estimates factory overhead at P450,000 for the next fiscal year. It is estimated that
90,000 units will be produced at a material cost of P600,000. Conversion will require an estimated 100,000 direct labor
hours at a cost of P3.00 per hour, with 45,000 machine hours.
Required: compute the determined factory rate base on.

 Material cost
 Units of production
 Machine hours
 Direct labor cost
 Direct labor hours
SOLUTION TO ILLUSTRATIVE PROBLEM

a. Factory over head rate = Est. factory overhead
Est. direct mat. Cost
= P 450,000
P 600,000
= 75% of direct mat. Cost
b. Factory overhead = Est. factory overhead

Est. units of production
= P 450,000
90,000 direct labor hours
= P 5.00/unit
c. Factory overhead rate = Est. factory overhead

Est. machine hours
= P 450,000
P 45,000 machine hours
= P 10.00/machine hours
d. Factory overhead rate = Est. factory overhead

Est. direct labor cost
= P 450,000
P 300,000
= P 150% of direct labor cost
e. Factory overhead rate = Est. factory overhead

Est. direct labor hours
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= P 450,000
P 100,000 direct labor hours
= P 4.50/ direct labor hours
The rate computed above is known as the plant-wide or blanket rate. All departments in the company will use
the same application will use the same application rate for factory overhead and also the same base. Some companies,
however, prefer to compute factory overhead on a departmentalized basis. The use of departmentalized rates will
improve the charging of overhead jobs and products.
STEPS IN COMPUTING OF DEPARTMENTALIZED OVERHEAD RATE
1. Divide the company into segments, called departments, cost centers, to which expenses are charge.
2. Estimated the factory overhead for each for each department ( direct department charges + indirect
departmental charges).
3. Select and estimate the base to be used by each department.
4. Allocate the service department costs to the producing departments.
5. Compute the factory overhead rate (similar to computation using blanket rate).
In a departmentalized company, factory overhead should be budgeted for each department. The procedures for
distributing the budget department expenses are identical to those use to allocate the actual factory overhead
expenses. Prior to the computation of the departmentalized factory overhead rate, management must make sure that
the service department cost have been allocated to the producing departments. Departmentalized overhead rates are
for the producing departments only. Producing departments, which include the production lines, are the cost-
accumulation centers in which work is performed directly on the goods being produced. On the other hand, service
department ,which include such activities as maintenance, personnel employee service, and the provision of heat,
power, and light are necessary for the entire factory – including the producing department – to remain in operation.
TYPICAL ALLOCATION BASES FOR COMMON COST
Most common costs can be group into four:

1. Labor-related common costs
2. Machine-related common costs
3. Space-related common costs
4. Service-related common costs
Common costs should be analyzed carefully to determine the most appropriate allocation base. The typical allocation
bases for communication cost are:
COMMON COST TYPICAL ALLOCATION BASE
LABOR-RELATED
1. Supervision number of employees, payroll amount or labor hours
2. Personnel service number of employee
MACHINE RELATED
3. Insurance on equipment value on equipment
4. Taxes on equipment value on equipment
5. Equipment depreciation machine-hours, equipment value
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6. Equipment maintenance number of machines, machine hours
SPACE - RELATED
7. Building rental space occupied
8. Building insurance space occupied
9. Heat and air conditioning space occupied, volume occupies
10. Concession rental space occupied & desirability and desirability of location
11. Interior buildings maintenance space occupied
SERVICE-RELATED
12. Material handling quantity or value of materials
13. Billing and accounting number of documents
14. Indirect materials value of direct materials
METHODS OF ALLOCATING SERVICE DEPARTMENT COST TO PRODUCING DEPARTMENTS
1. DIRECT METHODS- the most widely used methods. This method ignores any service rendered by one service
department to another, it allocates each service departments total cost directly to the producing department.
2. STEP METHOD - sometimes called sequential method of allocation. This method recognizes services rendered by
service departments to other service department. And is more complicated because it requires a sequence of
allocation. The sequence typically starts with the department and ends with the department that render service
to the greatest number of other service to the least number of other departments. Once a service departments
costs are allocated, no subsequent services rendered among all departments.
3. ALGEBRAIC METHOD – sometimes called reciprocal method. This method allocates cost by explicitly including
the mutual services rendered among the department.
Kappa Gamma company’s factory is divided into four departments- producing departments. Molding and
decorating, serviced by the buildings and grounds and the factory administration departments. Building and grounds
cost will be allocated using square feet (floor area) and factory administration cost will be allocated using direct labor
hours. In computing predetermined overhead rates, machine hours are used ass the base in molding and direct labor
hours as the base in decorating.
MOLDING DECORATING BUILDING & FACTORY

GROUNDS ADM.
Budgeted FO P400,000 P600,000 P80,000 P120,000
Direct labor hours 200,000 100,000
Machine hours 100,000 60,000 2,000 4,000
Requirements: allocate the cost of the service department using.

1. Direct method
2. Step method- start with Bldgs. & grounds
3. Algebraic method
SOLUTION TO ILLUSTRATIVE PROBLEM

1. DIRECT METHOD
MOLDING DECORATING B&G FA
Budgeted FO P400,000 P600,000 P80,000 P120,000
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Contact No. 228-1996/887-2051
Business Department
Allocated FO
B&G 50,000 30,000 (80,000)
FA 80,000 40,000 (120,000)
Total FO P530,000 P670,000
Base 200,000 MHrs 100,000DLHrs
FO rate P2.65/MHrs P5.70DLHr
Allocation of B & G cost

Molding = 100 x 80,000
160
Decorating = 60 x 80,000
160
Allocation of FA cost
Molding = 200 x 120,000
300
300
2. STEP METHOD
MOLDING DECORATING B&G FA
Budgeted FO P400,000 P600,000 P80,000 P120,000
Allocated FO
B&G 48,781 29,268 (80,000) 1,951
FA 81,301 40,650 (121,951)
Total FO P530,082 P669,918
Base 200,000 MHrs 100,000 DLHrs
FO rate P2.65/MHrs P6.70/DLHr
Allocation of B&G cost

Molding = 100 x 80,000
164
164
FA =__4 x 80,000
164
3. Algebraic method
Additional information for the illustrative problem.

Service provided by
B&G FA
Molding 50% 40%
Decorating 30% 50%
B&G - 10%
FA 30% -
Algebraic equation
B & G = 80,000 +10% (FA)
FA = 120,000+20% (BG)
Substitution:
B&G = 80,000 +10% (120,000 + .20BG
= 80,000 +12,000 + .20BG
.98BG = 92,000
BG = 92,000
.98
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= 93,878
FA = 120,000 + 20% (BG)

= 120,000 + 20% (93,878)
= 138,776
The allocation will be as follow:
Molding Decorating B&G FA

Budgeted FO P400,000 P600,000 P80,000 P120,000
Allocated FO
B&G 46,939 28,163 (93,878) 18,776
FA 55,510 69,388 13,878 (138,776)
Total FO P502,449 P697,551
CAPACITY PRODUCTION
Is the estimation of manufacturing overhead, as well as the estimation of the base to be used for allocation, it Is
important to be determine what capacity of production should be adopted.
a. Theoretical, maximum or ideal capacity – a capacity to produce a full speed without interruptions. It gives no
allowance for human capacity to the maximum nor due allowance for any circumstances that might result to a
stoppage of production with or not within the control of management.
b. Practical capacity - a capacity of production that provides allowance for circumstances that might result to
stoppage of production.
c. Expected actual capacity - a capacity concept base on a short range outlook which is feasible only for firms
whose product are seasonal or where the market or style changes allow price adjustments according to
competitive conditions and customer demand .
d. Normal capacity - a capacity of production taking into consideration the utilization of the plant facilities to
meet commercial demands served over a period long to level out the peaks and valleys which come with
seasonal and cyclical variations. This capacity is commonly used in the computations of overhead rates.
METHOD OF ACCOMULATION OF FACTORY OVERHEADS COST
1. Non-controlling account system - an account for each of overhead expense according to their nature is opened
in the ledger and charges to such account are made upon incurrence of the expense.
2. Controlling account system - an overhead control account is opened in the general ledger wherein the
overhead incurred are charged and a subsidiary ledger is maintained to show in detail the nature and account of
the expense.
Computation of overhead chargeable to individual cost sheets
Actual factor incurred per cost sheet x predetermined overhead rate
Entry to charge production with applied overhead:
Work in process – overhead xxx

Factory overhead applied xxx
FACTORY OVERHEAD VARIANCE - The difference between the actual factory overhead as shown by factory overhead
control account and the overhead charged to production as shown by the factory overhead applied account.
Classification of manufacturing overhead variance
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a. Underapplied overhead- the difference between actual overhead and applied overhead when the actual is more
than the applied.
b. Overapplied overhead - the difference between actual overhead and applied overhead when the actual is less
than the applied.
Causes of the manufacturing overhead variance:
a. Spending variance – the variance due to expense factor.
b. Idle capacity or volume variance- the variance due to difference in volume and activity factor.
Analysis of manufacturing overhead variance
a. Spending variance
Actual factory overhead variance P xxx
Less: budget allowed based on capacity used
Fixed factory overhead P xxx
Variable factory overhead xxx xxx
Spending variance P xxx
b. Idle capacity variance

Budget allowed based on capacity used P xxx
Less: factory overhead applied xxx
Idle capacity variance P xxx
Accounting for overhead variance
a. During the period prior to the closing of the books, the overhead variance is not recognized in the account and
the actual factory overhead account as well as the applied factory overhead accounts are kept open. When
interim financial statements are prepared and the variance is expected to be absorbs prior to year- end such
variance should be differed rather than disposed of immediately.
b. At the end of the accounting period.
1. If the amount of the overhead variance is immaterial or it is established to be the result of inefficiency, it is
closed to cost of goods sold.
2. If the amount of the overhead variance is materials and found to be the result of an erroneous computation
of the predetermined overhead rate such variance is distributed to the cost of goods sold, finished goods
inventory, and the work in process inventory.
The Davidson Corporation made the following date available from its accounting records and reports.
Budget factory overhead P 900,000
Budgeted direct labor hours 100,000 hrs.
Variable factory overhead rate P1.00/DLHR.
Actual factory overhead P350,000
Actual direct labor used 110,000 hrs.
SOLUTION- ILLUSTRATIVE PROBLEM

Spending variance:
Actual factory overhead P350,000
Budgeted allowed on actual hours
Fixed P200,000
Variance 110,000 310,000
Spending variance- unfavorable P 40,000
Idle capacity variance

Budget allowed on actual hours P310,000
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Contact No. 228-1996/887-2051
Business Department
Applied factory OH (110,000 x P3.00) 330,000

Idle capacity variance – favorable P(20,000)
To understand fully the computation of the variance, the following table may be prepared.
Total Per Hour

Fixed overhead P 200,000 P 2.00
Variable overhead 100,000 1.00
Total P 300,000 P 3.00
Factory overhead rate = 300,000

100,000hrs.
= P 3.00/DLHr.
Variable overhead cost = 100,000 Hrs. x P 1.00

= P 100,000
ACTIVITY BASED COSTING
The growth in the automation of manufacturing has brought many challenges to product costing. Increased of
robotics, specialized machinery, and other computer-driven process has change the nature of manufacturing and the
composition of total product cost. In many highly automated manufacturing businesses the significance of direct labor
cost has diminished and overhead cost have increased. The cost of acquiring installing, maintaining and operating state
of art manufacturing technologies has greatly increased overhead costs. In addition cost that used to be classified as
indirect such as quality control, computer programming, trouble shooting, and middle level management costs have
become major components of total production cost.
In highly automated manufacturing environment, overhead application rate base on direct labor may not
provide accurate overhead charges because they know longer represent cause and effect relationship between output
and overhead cost. The for more representative overhead application bases has led to activity-base costing (ABC) which
is also known as transaction costing. those activities(transaction) that consume overhead consume overhead resources
are identified and related to the costs incurred. The basic premise in activity-based costing is that overhead costs that
are caused by activities are traced to individual product units on the basis of frequency of consumption of overhead
resources by each product.
Traditional overhead is applied to production using one of the application bases which were have previously
discussed such as direct labor hours, machine hours, direct labor cost direct material cost and units of production. Direct
labor hours, direct labor cost, machine hours and units of production volume base on application bases. Volume base
production means that the units estimated to be produced, the larger the denominator in the equation use to determine
the overhead rate, thus the smaller the overhead application rate and it follows that the amount of overhead assigned
to each units will be lesser so overhead will be underapplied which is unfavorable.
Activity- based costing is a simple concept which can provide accurate information about a particular products
consumptions of overhead resources. ABC is base on the premise that if a product consumes many resources (activities)
that comprise overhead, it should bear a greater share of overhead costs than other product that does not consumes as
any activity units. In other words activity costing is also like riding LRT, the more you ride the more cards you need to
buy.
FIVE BASIC STEPS IN APPLYING ABC
1. Assemble similar actions into activity centers.
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2. Classify costs by activity center and by type of expense

3. Select cost drivers
4. Compute a cost function to associate and cost drivers with resource use.
5. Assign cost to the cost objective.
Assemble similar activities into activity centers
There are several number of actions performed in any organization so it will be difficult to relate to the cost of
every actions to a cost driver and then the product. Therefore, it will be the best to combine actions into activity centers.
One way of grouping actions is to classify them with different levels of activities, and namely, unit level activities, batch
level activities, product=level activities, and facilities level activities. Units-level activities are performed each time a units
is produced. Example- assembly, stamping, and machining. Costs of these activities vary with the number of units
produced. Batch-level activities are performed each time a batch of units is produced. The cost of these activities vary
according to the number of batches but remain fixed for all units in the batch. Example – machine set –ups, order
processing and materials handling. Product level activities are those performed as needed to support the production of
each different type of product . example productions scheduling, product designing , and parts and product testing ,
facilities level activities are those which sustain a facilities general manufacturing process. Example- plant supervision,
building occupancy, and personnel administration.
Classify costs by activity center and by type of expense

Assign costs to the activity centers where they are accumulated while waiting to be applied to products. Costs
that are traceable to activity center should be assigned directly to activity centers. Others cost shared by two or more
activity centers should be assigned according to some cost driver that controls the utilization of the costs involved.
Select the cost drivers

The cost divers are the links between costs, activity, and product. Cost drivers are not needed for direct cost
because this can be traced immediately to a product, however, indirect cost such as factory overhead needs links or
drivers to link a pool of costs in an activity center to the product.
Calculate a cost function

A cost function is used to translate the pool of cost and cost driver data into rate per cost driver units a
percentage of other cost amounts, just like the plant-wide or departmentalized factory overhead rate. For example, if
the cost of setup activity centers is P 25,000 and the selected cost drivers is 500 hours, then cost function will be P50 per
setup hour (P25,000/500hours).
Assigned cost to the cost objective

The last setup is to allocate the cost to the different user of the resources. This is done by multiplying the rate
determined in the preceding paragraph by the actual data of the cost driver. If actual setup hours used is 40, then the
allocated cost will be P2,000(40 hours x P50).
We now illustrate ABC by comparing it to one volume base overhead allocation procedures, namely direct labor
hours . for instance ,NDL company has three products namely C,D and E and three related overhead activities: product-
line setups, number of handles and number of parts. The number of part refers to the number of times each product
line is readied for production. The number of handles refers to the number of times each product is moved from one
work station to another. The number of parts refers to the number of parts used in making each product.
Units total direct total direct tot. direct no. of times no. of
product produced labor hrs. labor cost. mat. Cost set ups handled part
C 20 30 P 300 P 600 2 2 1
D 100 150 1,500 3,000 1 1 1
E 100 70 700 3,000 3 3 2
Budget cost of each cost driver
Setups P 6,200
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Times handled 3,300

No parts 3,000
Total budged overhead cost P 12,500
The overhead application rate using direct labor hours as base will be computed as
Factory overhead rate = P 12,500/250 direct labor hours

= P 50.00 per direct labor hours
Using direct labor hours as the base, factory overhead will be applied to the three products as follows:
total number of overhead cost
Product overhead applied units per units
C 30 hrs x P 50 P 1,500 20 units P 0.75
D 150 hrs x P 50 7,500 100 units P 0. 75
C 70 hrs x P 50 3,500 100 units P 0.35
The applied factory overhead when combined with the prime cost of each product will show it as follows.
Product C Product D Product E
Direct materials P 600 P 3,000 P 3,000
Direct labor 300 1,500 700
Factory overhead applied 1,500 7,500 3,500
Total cost P 2,400 P 12,000 P 7, 200
Cost per unit P 120/unit P 120/unit P72/unit
Under activity-based costing the factory overhead rate Is determined by dividing the total cost of each overhead activity
by the total frequency for each activity.
Set up (P6,200/6) = P 1,033.33 per set up
Handling (P3,300/6) = 500.00 per handling
No. of parts (3,000/4) = 750.00 per part
The full cost per unit of a product will be determined as follows:

Product C Product D Product E
Direct materials P 600 P 3,000 P 3,000
Direct labor 300 1,500 700
Factory overhead 3,917 2,333 6,250
Total cost P 4,817 P 6,833 P 9,950
Cost per unit P240.83/unit P 68.33/unit P 99.50/unit
The applied overhead cost of the product were determined as follows:

Product A
Setups 2 at P 1,033.33 P 2,066.67
Handling 2 at P 550.00 1,100.00
No. of parts 1 at P 750.00 750.00
Total overhead P 3,916.67
Product B
Setups 1 at P 1,033.33 P 1,033.33
Handling 1 at P 550.00 550.00
No. of parts 1 at P 750.00 750.00
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Product E
Setups 3 at P 1,033.33 P 3,099.99
Handling 2 at P 550.00 1,650.00
No. of parts 2 at P 750.00 1,500.00
Under the traditional method, direct labor does not explain the cause-effect relationship between the products
and incurring the overhead costs, on the table above it can be seen that product A has the highest cost followed by
product C. Product B has the lowest allocated overhead because B consumes less overhead activities than the other
products. By concentrating on each product consumption of the major cost component (overhead), activity costing
avoids the problem of overstating costs of product that are low level consumers of overhead activities and understating
cost of products that are high level consumers.
PART II. ASSESSMENT
[In this part, you may include assignments, learning activity, guide questions and/or homework]
PART III. SOURCES/REFERENCES
“Cost Accounting” by Guillermo M. De Leon Jr and Norma D. De Leon (2008 Edition)

“Cost Accounting”. Institute of Cost Accountants of India. (2016) (1st Edition)
“Cost Accounting” by Vinesh Ottuparammal, et. Al. University of Calicut (2016)
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KORBEL FOUNDATION COLLEGE, INC.

Purok Spring 1, Brgy. Morales, Koronadal City

SUBJECT CODE: ACCTG 31

ACCOUNTING FOR FACTORY OVERHEAD

BUDGETING FACTORY OVERHEAD COST

FACTORY TO BE CONSIDERED IN THE COMPUTATION OF OVERHEAD RATE

 Direct costing- method use for internal reporting ( management service)

Required: compute the determined factory rate base on.

SOLUTION TO ILLUSTRATIVE PROBLEM

= 75% of direct mat. Cost

b. Factory overhead = Est. factory overhead

c. Factory overhead rate = Est. factory overhead

d. Factory overhead rate = Est. factory overhead

= P 150% of direct labor cost

e. Factory overhead rate = Est. factory overhead

= P 4.50/ direct labor hours

STEPS IN COMPUTING OF DEPARTMENTALIZED OVERHEAD RATE

3. Select and estimate the base to be used by each department.

4. Allocate the service department costs to the producing departments.

TYPICAL ALLOCATION BASES FOR COMMON COST

Most common costs can be group into four:

COMMON COST TYPICAL ALLOCATION BASE

6. Equipment maintenance number of machines, machine hours

METHODS OF ALLOCATING SERVICE DEPARTMENT COST TO PRODUCING DEPARTMENTS

MOLDING DECORATING BUILDING & FACTORY

Requirements: allocate the cost of the service department using.

SOLUTION TO ILLUSTRATIVE PROBLEM

Allocation of B & G cost

Allocation of B&G cost

Additional information for the illustrative problem.

FA = 120,000 + 20% (BG)

The allocation will be as follow:

Molding Decorating B&G FA

METHOD OF ACCOMULATION OF FACTORY OVERHEADS COST

Computation of overhead chargeable to individual cost sheets

Actual factor incurred per cost sheet x predetermined overhead rate

Entry to charge production with applied overhead:

Work in process – overhead xxx

Classification of manufacturing overhead variance

b. Idle capacity variance

Accounting for overhead variance

SOLUTION- ILLUSTRATIVE PROBLEM

Idle capacity variance

Applied factory OH (110,000 x P3.00) 330,000

Total Per Hour

Factory overhead rate = 300,000

Variable overhead cost = 100,000 Hrs. x P 1.00

ACTIVITY BASED COSTING

FIVE BASIC STEPS IN APPLYING ABC

1. Assemble similar actions into activity centers.

2. Classify costs by activity center and by type of expense

Assemble similar activities into activity centers

Classify costs by activity center and by type of expense

Select the cost drivers

Calculate a cost function

Assigned cost to the cost objective

Times handled 3,300

Factory overhead rate = P 12,500/250 direct labor hours

The full cost per unit of a product will be determined as follows:

The applied overhead cost of the product were determined as follows:

PART II. ASSESSMENT

PART III. SOURCES/REFERENCES

“Cost Accounting” by Guillermo M. De Leon Jr and Norma D. De Leon (2008 Edition)